The gilt LDI crisis, 2022

At a glance

What happened

UK pension schemes hedge their long-dated liabilities with gilts, repo and swaps, usually with leverage so that a small pool of collateral supports a much larger hedge. After the government's mini-budget on 23 September 2022, long gilt yields jumped by more than a percentage point in days. The hedges lost value, collateral calls came due within days, and funds sold gilts to meet them, which pushed yields higher still. On 28 September the Bank of England stepped in with temporary gilt purchases to break the loop.

Why it went wrong

When yields rise a pension scheme's liabilities fall by more than its hedge, so its funding position improves. But the hedge settles in cash every day and the liabilities do not. Each call drained the collateral pool, refilling it meant selling gilts, and the selling moved yields up and triggered the next call. Because many schemes held the same position under the same rules, their individual sales added up to a market move. A solvency improvement became a liquidity emergency in about three working days.

What it teaches

A hedge and the thing it hedges rarely settle on the same timetable, and the gap is a funding need that nobody quotes. Leverage does not have to be speculative to be dangerous. Regulators now require LDI funds to hold collateral buffers sized for a yield move of around 250 basis points.

Key terms

Liability-driven investment

Investing to match the interest rate and inflation sensitivity of a scheme’s liabilities rather than to beat an index.

Gilt repo

Borrowing cash against gilts, the usual way an LDI fund obtains leveraged exposure.

Collateral buffer

The headroom a leveraged hedge holds so that a yield move produces a call it can meet without selling.

Funding level

A scheme’s assets against its liabilities — which improved through the crisis, even as its liquidity failed.

Doom loop

A self-reinforcing spiral where meeting a call requires selling the asset whose fall caused the call.

Financial stability operation

A central bank intervention aimed at restoring orderly markets rather than at setting monetary policy.

Where it sits in the course

Case studies like this one are used throughout risk management teaching, including FRM® preparation, as worked examples of leverage, collateral calls and funding liquidity risk. In OTC Learn the lesson runs in five steps: what happened, the position, why it broke, what it cost and what it teaches, followed by a worked example with the numbers. See the lesson outline.

Related case studies

• The LME nickel squeeze, 2022A hedge that could not be delivered into

The instruments behind it

OTC Learn lessons on the products this case turns on:

• Interest Rate SwapTrade fixed for floating payments
• Collateral and the CSAThe cash and bonds that back an OTC exposure